Thursday, September 20, 2012

Plutocratic Capital Flows: London Real Estate edition

I emphasized in a previous post that Wealth does not trickle down and much of the capital sloshing unproductively around the globe is going towards real estate purchases for the plutocrats as opposed to a sustainable growth. {For a less than charitable look at the (tongue firmly in cheek) "challenges" facing global plutocracy see Pathos of the Plutocrat (Krugman, 2012).}

It is unarguably a given that real estate affordability in places such as Manhattan and Central London is well beyond the reach of most citizens of the United States and United Kingdom respectively. But then the obvious question arises: who can afford such real estate and who is buying it? The expansion of shops such as Sotheby's International Realty is obviously a strong signal the demand exists and now research from Jones Lang LaSalle has been highlighted by John Authers in today's Financial Times. (bold emphasis mine) to show what foreign demand for purchases in Central London entails:

To
be clear about what the chart shows, it covers all new developments, including
two-bedroom flats or purpose-built estates, and not just new prime
developments. Developers currently find that they can sell such developments
“off plan” to buyers in south-east Asia who do
not even need to take a look at the property first. The implications are that
there is sufficient external demand to soak up a lot of extra supply, should it
come on tap, and that the London property market
is vulnerable to events in Asia, as well as in the Middle East and Europe.

London remains the world’s most coveted city, with foreign investment accounting for 75% of all transactions. Paris, New York and Tokyo also held strong appeal for global investors.

But flows of excess unproductive capital can be fleeting and prone to mass exits: it has happened before and --like the tides-- will happen again. Market appreciation at the high end of value chain has an annoying habit of making affordability difficult for the middle classes who embrace the idea of home ownership as a raison d'etre for what constitutes "a good life".

Moreover, with central banks en masse embracing easy money policies (such as QE3) in order to reflate assets, encourage mortgage borrowing via a flatter term structure and open the putative confidence channels in the hope that there will be greater consumption by an already indebted household sector, the ingredients are there for a new asset crash down the road that will (again) be international rather then local in scope with a potential bursting in Asia creating a domino effect of capital exiting save havens such as Canada and Australia. As (Chancellor, 2011) noted last year

Spain, Ireland
and to a lesser extent the US
all witnessed high levels of housing construction during the past decade. These
building booms left a terrible wreckage. Both Ireland
and Spain
ended up with more than a decade’s worth of housing oversupply. It has taken
the US
five years and counting to absorb excess supply of new homes.

The current
property booms in China,
Hong Kong and Singapore have
much in common with those across southeast Asia in the mid-1990s and in the
periphery of Europe in the past decade. In all
cases, dollar pegs and a currency union took the control of interest rates away
from the local central banks. Low rates inflated property bubbles.
Institutionalised prudence did not save Spain. Asian policymakers should
take note.

Key Takeaways:

The global plutocracy has more capital than it collectively knows what to do with.

Capital flows of the plutocracy continues to create demand for high end real estate in cosmopolitan cities such as London and Manhattan and save havens (e.g. Canada and Australia) provide a venue for assets as well.

Central banks pursuing easy money policies are encouraging asset reflation not productive investment and make economies less not more resilient to future shocks.